Pharmaceuticals for Beginners 2012
Comment of the Day

August 30 2012

Commentary by Eoin Treacy

Pharmaceuticals for Beginners 2012

Thanks to a subscriber for this highly educative 329-page report for anyone with an interest in the pharmaceuticals sector. Here is a section on diabetes:
Diabetes is not yet curable, but can be controlled. The goals of diabetes management are to attain and maintain a near-normal blood sugar level, and reduce the risk of complications.

In Type 1 diabetes, treatment depends on the individual's needs, but typically consists of an insulin regimen, which at present requires the regular injection of differing formulations of insulin. This often comprises daily injections of long-lasting insulin to provide a basal level similar to that of the normal body, together with separate injections of rapid/intermediate acting product to provide a ‘top-up' at meal times.

For Type 2 diabetics, treatment initially focuses on diet and exercise, as the loss of weight in obese patients helps to reduce the degree of insulin resistance. If this is insufficient, a range of oral medication may be started. Medication usually works by addressing one or several of the issues of Type 2 diabetes, e.g., reducing peripheral insulin resistance, reducing glucose production by the liver or increasing insulin secretion.

It should also be noted that diabetes is a progressive disease, where insulin resistance and ongoing beta cell death result in the patient progressing from a single oral therapy, to multiple oral therapies, to finally requiring insulin. At the time of diagnosis, only about 50% of pancreatic beta-cell function would remain, and this is estimated to continue to decline at an average of 4% a year. About 50% of patients will require more than one anti-diabetic medication by three years after their initial diagnosis, and this increases to 75% at nine years.

Eoin Treacy's view I reviewed a number of US pharmaceutical companies in yesterday's piece on shares which appear to be emerging from a 12-year process of valuation contraction. Due to the relatively predictable nature of pharmaceutical cash flows, they tend to have some of the more consistent patterns in terms of the progression of P/E multiples. Their valuations are therefore easier to monitor with charts.

The healthcare, energy and technology sectors are in a special category because ground breaking innovation in any one of them can literally create value where it had not previously been imagined. In the case of healthcare, new therapies can enhance standards of living, increase productivity and cut costs. Therefore, while many look at the healthcare sector as defensive, it unquestionably also has a growth aspect. Additionally, the expansion of the global disposable income class is creating additional demand growth for healthcare products which is likely to remain on a secular upward trajectory for a considerable period of time.

Diabetes is a global pandemic fuelled by increased calorie consumption and can be viewed from an investment perspective as a corollary of rising per capita incomes. (Also see Comment of the Day on December 28th 2011).

Novo Nordisk is an S&P 350 dividend aristocrat, yields 1.51% and could be considered a pure-play on diabetes medication. The share has rallied impressively and appears to have entered a process of mean reversion. However, a sustained move below DKK850 would be required to question medium-term uptrend consistency.

Fresenius Medical Care specialises in kidney dialysis machines and home care apparatus and yields 1.21%. The share completed a yearlong range in July and a sustained move back below €55 would be required to question medium-term scope for additional upside.

Sanofi is an S&P 350 dividend aristocrat and yields 4.06%. The share held a progression of higher to equal major reaction lows from 2009 and broke successfully above the psychological €60 in July. It is in the process of unwinding its short-term overbought condition but a sustained move back below €60 would be required to question medium-term upside potential.

Novartis is another S&P 350 dividend aristocrat and yields 3.98%. It rallied impressively over the last few months to test the psychological CHF60 area and is now unwinding the short-term overbought condition. Medium-term upside potential can be given the benefit of the doubt provided it finds support above or in the region of the 200-day MA which is currently at CHF52.90.

Roche is also an S&P 350 dividend aristocrat and yields 3.93%. The share found support in the region of the 2009 low from last year, consolidated above CHF150 from December and reasserted the medium-term uptrend last month. A sustained below the 200-day MA would be required to question medium-term scope for additional upside.

GlaxoSmithKline yields 5.03% and has held a progression of higher major reaction lows since 2009. It has paused below the psychological 1500p area for much of the year and will need to sustain a move above that level to confirm a return to medium-term demand dominance.

Astellas Pharma yields 3.38% and completed a three-year base in July. It has at least paused below ¥4000 and some additional consolidation of recent gains appears likely. However, a sustained move back below ¥3500 would be required to question medium-term upside potential.

Chugai Pharmaceutical (2.56%) rallied to break the more than two-year progression of lower rally highs in March and found support in the region of the 200-day MA from June. A sustained move below the MA, currently near ¥1430 would be required to question medium-term scope for additional upside.

Among the smaller companies with late stage treatments in the pipeline, Mannkind is worthy of mention. The company has never posted positive earnings and has a market cap of approximately $500 million putting it in the speculative category. However the share rallied last week to break the three-year progression of lower rally highs following a higher reaction low earlier this month. A sustained move below $2 would now be required to question medium-term scope for additional upside.

Following an impressive breakout in July, Lexicon Pharmaceuticals has returned to test the upper side of the underlying trading range. The $2 area represents the first area of potential support and provided it continues to hold in this area, the benefit of the doubt can continue to be given to demand dominance.

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